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Elite UK REIT ‘future-proofing’ with expanded mandate: CGSI

Jovi Ho
Jovi Ho • 7 min read
Elite UK REIT ‘future-proofing’ with expanded mandate: CGSI
Hilden House is located in Warrington Town Centre. Warrington lies between the business hubs of Liverpool and Manchester. Photo: Elite UK REIT
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The manager of Elite UK REIT — formerly known as Elite Commercial REIT — is future-proofing the UK-focused REIT with an expanded investment mandate, say CGS International (CGSI) analysts Lock Mun Yee and Natalie Ong.

For now, however, vacancies have weighed on the REIT, with its operating metrics for 1QFY2024 ended March 31 impacted by such costs. Hence, Lock and Ong have kept their “add” call in a May 8 note, while trimming their target price to GBP0.33 ($0.56) from GBP0.38 previously.

Elite reported on May 3 its 1QFY2024 revenue of GBP9.3 million, up 0.8% y-o-y, while net property income (NPI) dipped 3.7% y-o-y to GBP8.3 million as rental escalations were offset by higher holding costs from vacant assets.

This led to a 4.1 percentage point decline in NPI margin to 90.1%. Its 1QFY2024 distribution per unit (DPU) came in 21.2% lower y-o-y at GBP0.0067 due to higher interest cost and a 21% expansion in unit base from its preferential offering in 1QFY2024.

Elite’s portfolio occupancy stood at 92.3% at end-March. Aggregate leverage stood at 43.7%, with average debt cost at 5.2%.

Investment strategy

See also: Elite Commercial REIT reports 1QFY2024 DPU of 0.67 pence, 21.2% lower y-o-y

Elite’s unique value proposition lies in its portfolio of what the CGSI analysts describe as 150 “bite-sized” assets in the UK, as at end-2023. The majority of these properties are leased to the UK’s Department for Work and Pensions (DWP).

In April, the manager announced an expanded investment mandate into newly identified growth sectors, such as purpose-built student accommodation (PBSA) and built-to-rent (BTR) residential.

Lock and Ong believe this would allow it to diversify its tenant base, enhance value and future-proof its portfolio. They also think the REIT could achieve a potential 7.5% boost to book NAV and lower gearing. “Elite’s book NAV could be potentially lifted to GBP0.42 per unit while its aggregate leverage could be reduced to 37.7%, from 43.7% as at 1QFY2024 over the next two to three years.”

See also: Elite Commercial REIT expands investment strategy to include UK PBSA

According to CGSI, this will come from selling and reinvesting in a stake in repositioned assets, divesting Peel Park land and monetising five vacant assets.

Lock and Ong explain: “There could be further improvements to our projected NAV and gearing estimates should Elite be able to sell the vacant properties at a premium.”

Lindsay House

Management has shared that Lindsay House in Dundee, Scotland, is a prime candidate for PBSA conversion and it is in the pre-planning and approval stage. Lock and Ong believe this will be accretive to the REIT. The property is slated to be converted into a 200-bed student housing facility upon approval from the authorities.

According to a May 6 note by PhillipCapital Research analyst Liu Miaomiao, typical values are around GBP130,000 per bed with yields of 5.5%. Liu has lowered her target price to GBP0.32 from GBP0.34 previously, while holding a “buy” call on the REIT.

Lindsay House is sitting on a land area of 0.36 acre with a total net lettable area of 38,803 sq ft. According to CGSI, the property is located near two universities and existing PBSAs. The property is an 11-minute walk from the University of Dundee and a seven-minute walk from Abertay University.

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The property was vacated as part of DWP’s lease re-gearing exercise, and the dilapidation settlement was completed in 2H2023.

Dundee has an estimated undergraduate and graduate student population of 40,000. The city has one of the highest student-to-population ratios in the UK, at 1:5, of which the University of Dundee makes up 40% of the student pool, with some 16,000 students last year.

That said, Dundee is not the largest PBSA market in the UK and it remains relatively undersupplied, says CGSI, with the highest student-to-bed ratio of 3.15:1 as at August 2023, compared to the national average of 2.1:1.

Based on Cushman & Wakefield’s UK 2023 report, the development pipeline remains fairly limited. CBRE’s UK real estate market outlook 2024 report quoted Unite Student, the UK’s largest PBSA player, as predicting rent growth of more than 5% for the 2024/2025 leasing cycle.

A potential 200-unit PBSA development at Lindsay House could be valued at GBP30 million upon completion, say Lock and Ong. “Taking this into account and after factoring in development costs, we project a net gross asset surplus of GBP2.2 million or GBP0.004/unit.”

Hilden House

Management has also shared that Hilden House could be converted into a BTR residential project. CGSI believes this will likewise be accretive to Elite.

Hilden House is located in Warrington Town Centre and surrounded by a mix of office, retail and residential properties. Warrington lies between the business hubs of Liverpool and Manchester.

The five-storey property was vacated by the DWP, with dilapidation settlements completed in 2023. The property sits on a 0.32ha site and has 50,841 sq ft of net internal area. According to Knight Frank, there are 5.7 million households renting in the private sector across the UK as of end-2023.

The current operational BTR supply caters to some 1.9% of these households and the proportion is expected to rise to just 3%, including those in the construction pipeline.

Based on a potential conversion into a 77-unit BTR development with an estimated gross development value of GBP12.2 million, Lock and Ong calculate the implied residual land value for Hilden House to be an estimated GBP3.1 million, a 12.3% premium over its FY2023 book value of GBP2.8 million.

“Given the relatively low development amount, we believe Elite could sell the property to a joint venture vehicle,” note the CGSI analysts.

They estimate the BTR development could command a market value of GBP13.6 million. “We project a net gross asset surplus of GBP0.5 million, or GBP0.001/unit. We believe Elite can utilise the divestment proceeds to pare down debt in the near term.”

Peel Park

Elite has identified an alternative use for part of the undeveloped land, including developing a potential low emission and low latency data centre project out of Peel Park, its largest asset. Management has received a “positive pre-application response” from the authorities in Blackpool, says CGSI.

Peel Park is located within the Blackpool Fylde Industrial Estate and is currently used by DWP as a technology hub.

The property has a net lettable area of 156,542 sq ft and sits on 15.65ha of land, including associated car park space. Three-quarters (11.7ha) of Peel Park is currently undeveloped grassland. Management said 60MVA of power has been secured, sufficient to power two co-located data centres. The site is surrounded by renewable energy infrastructure; according to management, major offshore wind farms are to be constructed 25 miles (40km) from Blackpool and likely to be operational in 2028. The latter project is backed by a joint venture between BP and Energie Baden-Wurttemburg, two of the largest energy companies in Europe.

CGSI believes the data centre development will be accretive. “The best use of the land parcel is for data centre development rather than retaining it for commercial or general industrial use.”

Comparing against nearby cities and accounting for Blackpool’s relatively lower level of economic activity, CGSI estimates industrial land values to be closer to GBP400,000 per acre. “Using this as a benchmark, we estimate the sale of land for the data centre developments could generate GBP8.2 million.”

Based on calculation of the residual land value at a 30%–35% discount to that in other established locations, CGSI derives a residual land value of GBP14.8 million.

CGSI believes Elite will divest the land parcel instead. “Assuming the divestment proceeds are utilised to pare down debt, aggregate leverage (post-preferential offer) could decline to 41.9%–42.4%, from a pro-forma end-FY2023 leverage ratio of 43.7%.”

Five vacant assets

Elite has another five largely vacant properties as at end-2023. Two have completed dilapidation settlements (Ladywell House and Sidlaw House) and three are under dilapidation settlement negotiations (St Paul’s House, Victoria Rd and Crown Buildings).

The valuation of these properties has been written down by 7% y-o-y, reflecting their vacated status, says CGSI. “We believe these assets could be potentially divested, once the dilapidation settlements are finalised.”

Photos: CGS International, Elite UK REIT

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